Your guide to Telstra's Share Buy-Back

Share buy-backs – especially big ones like Telstra’s – do a lot to stir the pot of public debate. To some they’re a case of Santa come early, showering gifts on shareholders; to others they’re a sign of a company down on its luck, bereft of imagination and opportunities for growth; and to still others, they’re way of making a balance sheet ‘more efficient’ to somehow conjure up additional returns.

The truth is more prosaic. A share buy-back is simply a means of giving shareholders back a chunk of their own money, and whether they make sense or not depends on whether its best for shareholders to have the money or for the company to keep it.

The effect of a share buy-back is almost identical to that of a dividend, except that instead returning cash to all shareholders and all shareholders maintaining the same interest in a slightly reduced pie, the cash is only returned to those shareholders that wish to take part, whose share of the pie is proportionately reduced.

Herein lies the magic if there is any. Because all shareholders are different – particularly in terms of tax – it makes more sense for some to get their money out than for others, and a buy-back enables them to do this, while others can maintain their investment (a slightly larger share of a slightly less valuable company).

It gets even better when the buy-back is conducted off-market via a tender, as Telstra’s will be, because the keener some shareholders are to take part, the bigger the discount they’ll accept, and the more the non-participants will see their proportionate share increase. So the tender process should spread the benefits on offer more fairly among all shareholders.

But we’re getting ahead of ourselves. Before we consider whether it makes sense to stay or to go, let’s run through what’s actually happening.

What's happening?

After a couple of recent disposals, Telstra has found itself with less debt than it thinks it should have to strike a balance between risk and returns (all things being equal, more debt will increase returns to shareholders but at greater risk). To get back to where it wants to be, in addition to paying out about $3.6bn in dividends this year, management has decided to return another $1bn by buying back shares.

It will do this via an off-market tender offer, which basically means that shareholders are invited to submit a price at which they’d be prepared to sell their shares. The offers will be accepted from the bottom up, until the $1bn target is reached, so that those accepting the biggest discounts are more likely to have their offers accepted. You can also select a minimum price at which you’d be prepared to sell your shares, and/or you can opt to have your shares bought back at whatever is the final price that would make that possible.

The offer relates to shares bought on or before 19 August 2014 and the forms, which were mailed out this week, will need to be received back by the company’s registrar (Link Market Services) by 7pm on Friday 3 October.

Should you take part?

So should you take part? Here’s where it gets difficult because, as we’ve noted above, everybody is different (particularly in terms of tax) so there is no one-size-fits-all answer. The way it works is that the price eventually paid for the shares is split between a capital component (which the ATO has said is likely to be $2.33) and a dividend component (the rest of the price).

On the dividend component, you’ll pay tax at your marginal rate offset by a full franking credit, as with a regular dividend; and on the capital component you’ll be subject to capital gains tax (CGT) on the difference between the cost of the shares and $2.33 per share plus an adjustment based on the difference between the market price and the final buy-back price (see section 4.1 of Telstra’s Buy-Back Booklet). The CGT discount will be available if you’ve held the shares for more than a year and if you make a capital loss then it can be used against capital gains in the current year or carried forward to future years.

So the Buy-Back is likely to be more attractive to people (or super funds) on low tax rates, and/or who stand to make a capital loss on the shares and can make good use of it against gains elsewhere. And, of course, the lower the discount on the buy-back price, the more attractive the deal will be.

Table 1: Telstra's illustrative examples

Marginal tax rate

0%

Super
Fund
(15%)

21%

34.5%

39%

49%

Assuming market price = $5.30; discount = 10%; cost base = $4 *

Buy-back price ($)

4.77

4.77

4.77

4.77

4.77

4.77

After-tax proceeds of Buy-Back ($)

5.82

5.41

5.21

4.82

4.68

4.39

After-tax proceeds of ASX sale ($)

5.30

5.17

5.16

5.08

5.05

4.98

Profit/(loss) for Buy-Back and
replacing shares on market

0.52

0.11

(0.09)

(0.48)

(0.62)

(0.91)

Profit/(loss) for Buy-Back vs
selling on market

0.52

0.24

0.05

(0.26)

(0.37)

(0.59)

Note that these are illustrative examples only, from Telstra's Buy-Back calculator; we recommend making your own calculations and/or speaking to your tax adviser

* This also assumes zero brokerage, that the Telstra shares have been held for more than a year, and that capital losses can be used against gains held on shares that have also been held for more than a year

All of this is explained in greater detail in Telstra’s Buy-Back Booklet, available from its website (you’ll need to go through a brief verification process). In particular, in Section 4.6 (on page 20) there’s a table setting out how the proposal might pan out for people on different tax rates (See Table 1). It’s important to note that the prices and some other details will change, but it provides a good basis for working through the various possibilities. Telstra also provides a downloadable spreadsheet which you can use to test different scenarios (available from the same link given above).

Roadtesting

The share price up 2% since we reviewed Telstra's 2014 annual result, putting it towards the top of our Hold range, so it may make sense for some people to use the Buy-Back to trim their holdings.

Bear in mind that it might also be worth participating even if you don’t want to reduce your holding, because you can always buy the shares back on the market, but this is likely to be less attractive for most situations as you’ll have to absorb the discount. There are also risks to this approach as the price may change between the Buy-Back and when you replace the shares and there may also be tax implications (such as resetting the clock for the CGT discount).

After extensive roadtesting of Telstra's Buy-Back Calculator and while noting that we’re not able to provide personal advice, we’d say it’s hard to find scenarios where those on the highest tax rates will benefit from participating (see Table 2). At the other end of the spectrum it looks like super funds will benefit in most situations at least as compared with selling on market, and even when repurchasing the shares as long as the discount isn’t too big. In the middle, things get more marginal.

Everybody is different, though, so we’d recommend having a play with the calculator yourself, running through the methodology in Section 4.6 of the Buy-Back Booklet, and/or speaking to your personal tax adviser.

Table 2: Further illustrative examples, for market price of $5.72*

Marginal tax rate

0%

Super
Fund
(15%)

21%

34.5%

39%

49%

Discount = 14%

Market price ($)

5.72

5.72

5.72

5.72

5.72

5.72

Buy-back price ($)

4.92

4.92

4.92

4.92

4.92

4.92

After-tax proceeds of Buy-Back ($)

6.03

5.56

5.34

4.90

4.76

4.43

After-tax proceeds of ASX sale ($)

5.72

5.55

5.54

5.42

5.38

5.30

Profit/(loss) for Buy-Back and
replacing shares on market

0.31

(0.16)

(0.38)

(0.82)

(0.96)

(1.29)

Profit/(loss) for Buy-Back vs
selling on market

0.31

0.01

(0.20)

(0.52)

(0.62)

(0.87)

Discount = 10%

Market price ($)

5.72

5.72

5.72

5.72

5.72

5.72

Buy-back price ($)

5.15

5.15

5.15

5.15

5.15

5.15

After-tax proceeds of buy-back ($)

6.36

5.87

5.63

5.16

5.00

4.66

After-tax proceeds of sale on ASX ($)

5.72

5.55

5.54

5.42

5.38

5.30

Profit/(loss) for Buy-Back and
replacing shares on market

0.64

0.15

(0.09)

(0.56)

(0.72)

(1.06)

Profit/(loss) for Buy-Back vs
selling on market

0.64

0.32

0.09

(0.26)

(0.38)

(0.64)

Discount = 6%

Market price ($)

5.72

5.72

5.72

5.72

5.72

5.72

Buy-back price ($)

5.38

5.38

5.38

5.38

5.38

5.38

After-tax proceeds of buy-back ($)

6.69

6.17

5.91

5.42

5.25

4.88

After-tax proceeds of sale on ASX ($)

5.72

5.55

5.54

5.42

5.38

5.30

Profit/(loss) for Buy-Back and
replacing shares on market

0.97

0.45

0.19

(0.30)

(0.47)

(0.84)

Profit/(loss) for Buy-Back vs
selling on market

0.97

0.62

0.37

0.00

(0.13)

(0.42)

Note that these are illustrative examples only, based on Telstra's Buy-Back calculator; we recommend making your own calculations and/or speaking to your tax adviser.

* This also assumes zero brokerage, that the cost base is $4, that the shares have been held for more than a year, and that capital losses can be used against gains held on shares that have also been held for more than a year.

InvestSMART Publishing Pty Ltd holds Australian Financial Securities Licence (AFSL) 282288.
The content of this website is general in nature and does not take the personal situation of any user of this website into consideration.
A user of this website should seek financial advice specific to that user’s situation before making any financial decision.
Past performance of any security or financial product is not a reliable indicator of future performance. InvestSMART Publishing Pty Ltd
encourages users of this website to view investing as a long-term pursuit.